Flush times, but money isn't going into productivity

1of 2Gregory Pierre assembles wristwatch mechanisms at the Shinola manufacturing facility in Detroit. Businesses are making record profits, but nonresidential fixed investment — what businesses spend on equipment and software — still hasn't bounced back or made up for lost ground from the record lows of 2009.Photo: Carlos Osorio / Associated Press

2of 2Sherle Mir works on an assembly line in Whitewater, Wisconsin. The manufacturing sector is operating at 77.8 percent capacity, according to Federal Reserve data.Photo: Nam Y. Huh / Associated Press

Five years into the economic recovery, businesses are making record profits, cash hoards are strong and borrowing is exceptionally cheap. But companies aren't plowing much money into big-ticket investments for the future.

Nonresidential fixed investment — what businesses spend on equipment, software, buildings and intellectual property — still hasn't bounced back to its pre-crisis share of the economy, let alone made up for lost ground from the record lows of 2009.

Equipment spending in particular has averaged 5.2 percent of the economy over the past five years, as the Wall Street Journal noted recently, down from 6.5 percent over the previous half-century.

If companies increased their spending enough to close that gap, it would mean an extra $220 billion in annual economic activity and perhaps a couple of million more jobs.

But there might be even more important and lasting consequences for this lack of spending by businesses.

Capital spending improves worker productivity. And worker productivity improves living standards. Less capital spending by businesses means less investment in the kinds of equipment, software and intellectual property that will make the economy more competitive over the long haul.

The logic is simple.

If you have a ditch-digging business and employ one guy with a shovel, you can significantly increase the number of ditches he can dig by spending $30,000 on a Bobcat T190 earthmover — with the trencher attachment. The same could be said of an expensive new software package that makes your sales force log more calls to the right people, or research and development lab equipment that leads to patents and better products.

The pattern the past three years has been steady increases in the number of hours Americans are working, combined with unimpressive increases in the total value of the stuff being made. That is a recipe for terrible numbers on productivity, including a mere 0.5 percent rise in worker productivity for all of 2013. If you believe the first-quarter numbers this year (which deserve some skepticism), the United States experienced a steep 3.2 percent decline in productivity to start this year.

A lot of guesswork goes into measuring, let alone understanding, changes in productivity, but it's reasonable to see underinvestment by U.S. businesses as a prime suspect in the underperformance.

The question is whether that is poised to change.

There is most likely some interplay between the weak capital spending numbers and the weak job market of the past few years; there is less incentive to spend money on productivity-enhancing equipment when labor is cheap.

As the job market tightens and workers have better leverage in demanding higher wages, spending money on equipment becomes more attractive. To return to our ditch-digging business, you might be more inclined to spend thousands of dollars on that earth mover when the going rate for a laborer is $12 an hour as opposed to $10.

In that sense, an improving job market could increase capital spending, which in turn would create a virtuous cycle of more economic activity, more jobs and higher productivity.

Another reason for optimism on capital spending, made by Scott Anderson, chief economist of Bank of the West, is the nation's factories are starting to run closer and closer to their capacity, which implies that they will need to spend for more equipment to meet higher demand.

The manufacturing sector is operating at 77.8 percent of its capacity, according to Federal Reserve data, well above the 76 percent average during the previous expansion and not far from the 79.1 percent peak during the mid-2000s.

“As manufacturing approaches full capacity, wage pressures will build and many businesses will be forced to redirect their profits away from stock buybacks and toward actual physical investment, which will help bolster U.S. GDP,” Anderson writes in a research note.

But it's worth adding right now, the idea of a wave of business spending is more speculation than reality. Orders for nondefense capital goods excluding aircraft, a good forward-looking measure of companies' intentions on the equipment front, has bounced around between $70 billion and $71 billion a month for the past three months. It has not exhibited a clear upward trend.